Sun halts investments from $1bn hybrid securities fund

Poor performance and the inability to affect turnarounds with minority stakes has caused Sun Capital to discontinue making new investments from the hedge fund it raised in 2006.

Sun Capital Partners has decided to stop making investments from its hybrid hedge fund and will return money to limited partners as it exits investments from the fund, according to people with knowledge of the situation. The fund raised more than $1 billion in 2006.

Some employees with the securities fund were made redundant earlier this year; all remaining investment professionals and support staff will shift to the buyout fund to focus on finding and executing deals, a source said.

Sun Capital Securities Fund had its last large close in 2006 and was launched to expand Sun’s strategy from turning around troubled businesses through control stakes to investing in minority positions in public securities.

The fund’s performance has not lived up to the firm’s expectations, according to sources, especially after the stock markets crashed in the financial downturn. The fund’s minority investment strategy left the firm without the control it felt necessary to affect a proper turnaround, a source said.

Sun was “getting itself into public situations where it felt, if it had control, it could have made a world of difference, but because of the minority position, it didn’t have the latitude it initially expected to influence other stakeholders and drive the necessary change”.

Earlier this year, Sun shifted its strategy in the securities fund from investments in minority stakes in public companies to distressed debt for control. Sun will continue to make distressed-debt-for control investments from its fifth buyout fund, which closed on $6 billion in 2007, has more than $4 billion in dry powder and shares many of the same LPs with the hedge fund.  LPs from the hedge fund support Sun’s decision to stop making new investments, a source said.

Capital will be returned to LPs in the securities fund as it makes exits, instead of recycling returns back into the fund, a source said. Any unspent capital will be used to maximise returns on liquid investments in the fund.

Sun is not “winding down” the securities fund, a source said, but has time to wait to exit investments at the right price. For example, the firm can wait for public securities it bought from the fund to hit a target stock price before selling. The fund also includes some traditional private equity investments, which the firm will hold for five to seven years before exiting.

Sun Capital has had at least 10 of its portfolio companies go bankrupt in the market downturn. One of its biggest investments, California retailer Mervyn’s, slid into bankruptcy last spring and then into liquidation in the fall after it failed to attract any buyers. Yesterday, Anchor Blue, a US clothing retailer Sun bought in 2003, filed for voluntary Chapter 11 protection.

The firm has let go more than 30 employees from its 200-person workforce since the beginning of the year and closed its Tokyo office.

Sun, which was established in 1995, is led by co-chief executives Rodger Krouse and Marc Leder, both of whom worked previously as senior vice presidents at Lehman Brothers.